ETF Securities Research Blog

Trump’s got China right…but for the wrong reasons

The Renminbi is being manipulated, but Trump has it wrong: Chinese policymakers are helping stabilise the currency. The Renminbi is one of the least volatile global currencies as a result.

Chinese policymakers intervene in currency markets to keep the currency within a +/- 2% band from the close of the previous day’s closing rate. This process either generates foreign exchange reserves (if it sells Chinese currencies) or reduces reserves (if it supports the Renminbi). Foreign exchange reserves have fallen under the US$3tn level for the first time in six years, after peaking at US$3.99tn in June 2014. January’s US$12bn decline in foreign reserves could have been worse. Excluding valuation effects the decline would have been closer to US$40bn.

The weakening of the Renminbi during 2016 prompted domestic investors and savers to look abroad in order to not lose purchasing power and boost investment returns in the face of the strong US Dollar. There are signs of a turnaround: the Renminbi has strengthened during 2017, likely assisting in reducing capital outflows. In addition to greater capital controls, the People’s Bank of China has increased rates on short-term repos for the first time since 2013, helping motivate more investors to keep currency in mainland China. The domestic outlook appears to be also helping, with our modified ‘Li Keqiang Index’ showing more stable growth in China over the past year.

Estimates suggest that currency outflows have continued unabated since early 2015, totalling US$1.7tn over the period. Stemming the outflow of capital is a critical issue for Chinese authorities – a currency collapse could occur if China liberalises currency controls too fast, forcing the currency sharply lower and exacerbating capital outflows. Indeed, President Trump would be well served to improve Sino-US relations and support the Chinese efforts to stabilise its currency. With only the nascent signs of inflation appearing on a global level, a Chinese currency collapse could spark a new wave of global deflation, something the developed world does not need right now.